We Need to Talk About Netflix’s Ad Numbers

Netflix co-C.E.O. Ted Sarandos. Photo: Franco Origlia/Getty Images
Julia Alexander
May 23, 2023

The TV upfronts are an exercise in the art of obfuscation, or framing, or simple B.S., as my colleague Matt Belloni recently wrote. Media companies are selling advertising agencies and Fortune 100 C.M.O.s on the idea that their series, or platform, is the most brand-safe, or the most Gen Z-friendly, or the best place for allergy medication spots. Indeed, this was all much easier when the media industry agreed upon a simple medium (linear) and there was one analytics platform (Nielsen), which informed ad spend better than just about anything else. You could simply look at the 8 p.m. slot on Wednesday and see that, yes, Dick Wolf was still TV’s magnetic draw. 

Of course, Netflix upended all this and brought the transformation full circle last week with its first appearance at the upfronts, albeit via a virtual showcase, touting some strong numbers for its advertising tier, which only launched six months ago. Netflix’s main argument coalesced around 5 million global monthly active users, but… five million of what exactly

In retrospect, it wasn’t entirely clear what the company has achieved. Netflix either added 5 million customers or 5 million monthly active users. A subscription is measured per account (like subscriber figures presented in financial earnings). Monthly active users effectively include all profiles watching on one account. This is key to ensuring that ads aren’t shown on children’s profiles. The difference may seem pedantic, but the breakdown of those users within the advertising tier, including whether or not they descended from the ad-free tier or were net new subscribers, is key to understanding the platform’s momentum.

I’m not suggesting that Netflix’s ad tier isn’t promising. The company noted in its recent earnings that average revenue per member is already higher on the ad-supported tier, which blends ads and subscription revenue for a figure the company hasn’t disclosed. Currently, Netflix makes $16.18 per user in the U.S. and Canada region, but that isn’t broken into ads or no-ads in the company’s financials. Netflix hasn’t actually stated how many members in that plan are in the U.S. and Canada. With a little more than one million domestic customers joining Netflix since the ad-tier launched, we can presume two things: 1) most additions to the ad-supported tier are likely coming in from other territories, including Europe/Middle East/Asia (EMEA), which saw an additional 3 million new customers in the quarter when the ad tier launched; and 2) even if cannibalization were to occur within Netflix’s U.S. market, the stronger average revenue per member wouldn’t negatively impact the business per se

Netflix may be the new normal in entertainment, but its ad business is still simply just new. It’s actually late to the party of combining advertising and subscription revenue; Peacock launched with an ad-tier focus, HBO Max and Paramount+ added advertisements early into their existence, and Hulu has championed blended revenue for years. But it’s also, of course, the most significant entrant into the market, by virtue of its size. Now that Netflix has released its first tranche of data, let’s examine three of the bigger questions about advertising and streaming as it stands today, and where it’s headed. 

Tiers for Fears

First, here are some key statistics about ad-supported tiers from the media research firm Antenna: When given the option, 58.3 percent of customers opt into at least one ad-supported plan; one of every two customers signing up for HBO Max, Peacock, or Paramount+ are on the ad-supported tier; some 75 percent of all customers signing up for Netflix’s ad-supported tier also have an ad-supported subscription to another platform. Currently, only a miniscule fraction of Netflix’s current subscribers are on the ad-supported plan, according to Antenna data through March 2023. 

How many customers, trained for years to experience Netflix without ads, will sign up to do so going forward? Many analysts still see strong upside for Netflix in the ad market, even at a time of softening rate cards in the marketplace. I do, too. For one, Netflix is cracking down on password sharing in earnest. Emails are going out to customers in the U.S. today alerting households with users outside the home that those viewers will have to pony up $8 to continue streaming. Some may see it as a potential churn crisis at a time when all eyes are on streaming stability. Some view it as the perfect opportunity to capture more price-sensitive users, with a possibility of 30 million customers in the U.S. and Canada alone using but not paying for Netflix. 

Netflix is also smart to get its ad-supported product in place, and work out the kinks, before raising prices again—an inevitability given the pressure on streamers to pay off debt, balance their P&Ls, and produce more content. As Warner Bros. Discovery C.E.O. David Zaslav noted publicly the other day (and every streaming executive privately agrees), pricing across the entire industry is way too low to be sustainable. Especially with the current wave of consolidation (Disney+ and Hulu, HBO Max and Discovery, etc.), the expectation is that more households will transition from premium plans to cheaper, ad-supported tiers. 

Of course, Netflix is also an outlier in the market. Whereas endless M&A chatter attends WBD, Paramount, and NBCUniversal, Netflix has already achieved both scale and profitability in streaming. It’s also one of the streamers that customers are least likely to cancel (it still maintains one of the lowest churn rates in the industry, even as that rate continues to increase industrywide) —which means it may also be the service that customers are least likely to downgrade. After all, the platforms we spend the most time on are the ones where the experience matters most. If Netflix continues to dominate in consumption (Netflix maintained 6.9 percent of all streaming time in April, according to Nielsen), it’s possible that fewer subscribers than expected will ultimately switch from the more expensive ad-free version (which presumably generates less revenue for Netflix than the combined version, based on Netflix’s recent earnings report) to the cheaper ad-supported tier (which actually generates more), at least in the U.S. and Canadian market. Globally, however, it’s a different story…

The Global Conquest Play 

There is a misconception that winning the global market simply comes down to producing an international superhit, like Squid Game, every quarter. But the reality is actually even harder: Global success isn’t a function of the number of hits, but rather the ability to penetrate and scale in individual markets, region by region. Netflix has a head start over its competitors in this department, but it’s still near the starting line in places like India and Turkey, where the business has a foothold but is still years away from the sort of singular cultural dominance that it’s achieved in the U.S.

Part of the difficulty is that emerging markets haven’t yet built a real culture around streaming. In the U.S., scripted content on pay TV makes up less than a quarter of what people are viewing, in large part because most of that programming is now being made for streaming, not cable. In the U.S., we’ve pushed a majority of the audience to streaming, which has consequently affected the entire content development pipeline. 

Internationally, however, where pay TV is much cheaper on average, and the best content is still being made for linear, there are fewer reasons to cut the cord—especially in key regions, like India, where Netflix and others have struggled. To build a culture around streaming, you first need significant market adoption. Historically, that’s meant operating at a loss to onboard hesitant customers. But this may actually provide an opportunity for Netflix to accelerate the growth of its ad-tier footprint outside the U.S. 

Sure, lowering one hurdle (price) doesn’t take down the other hurdle, which is content. Netflix still needs to acquire and program for hyper-regional tastes. But offering a cheaper ad-supported tier could be a gamechanger in more price-conscious households in new international markets, which is the first step toward mass adoption—and, eventually, rising pricing power and stronger advertising CPMs. 

Pay TV Parity?

The final piece of this puzzle, of course, is whether Netflix’s push into ads and the growth of blended-revenue models help the streaming business eventually match the profits generated by cable on content alone. I’m skeptical—and, frankly, it’s far too complicated to fully assess in this column. Former Turner executive and current BCG senior advisor Doug Shapiro recently noted that “​​traditional TV monetizes at about twice the rate of streaming TV per hour of consumption.” Factor in the splintering of video audiences across YouTube, TikTok, video games, and the hundred other platforms and channels competing for our attention, and you begin to see the problem. Ultimately, consumers judge streamers by the value of their shows and movies. Advertisers will follow where those consumers’ eyeballs travel. But the winners and losers will live and die by their business models.

Nevertheless, Netflix may be one of the few streamers in a position to make advertising work. As my colleague Bill Cohan pointed out, Netflix is the only major platform generating a profit (an expected minimum of $3.5 billion of free cash flow by the end of the year, an increase in guidance per the most recent earnings report). The counterargument, of course, is that Netflix is currently offering advertisers one of the smallest potential audiences for their product. No wonder Netflix’s recent upfronts pitch was so focused on future opportunities, rather than who they can reach right now. Ted Sarandos and Greg Peters are essentially asking advertisers to trust them, to get in on the ground floor of something new and exciting, and potentially very valuable. If industry veterans are nervous, it’s because they’ve seen this movie before.